Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Capital One Financial Corporation's (NYSE:COF), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Capital One Financial has a P/E ratio of 8.25. That means that at current prices, buyers pay $8.25 for every $1 in trailing yearly profits.
How Do You Calculate Capital One Financial's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Capital One Financial:
P/E of 8.25 = $93.25 ÷ $11.30 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Capital One Financial's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (8.3) for companies in the consumer finance industry is roughly the same as Capital One Financial's P/E.
Capital One Financial's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Capital One Financial grew EPS like Taylor Swift grew her fan base back in 2010; the 51% gain was both fast and well deserved. And earnings per share have improved by 17% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Capital One Financial's Debt Impact Its P/E Ratio?
Capital One Financial has net debt worth 72% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Bottom Line On Capital One Financial's P/E Ratio
Capital One Financial's P/E is 8.2 which is below average (17.8) in the US market. The company may have significant debt, but EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Capital One Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.